When it comes to CRM, which is all about relationships, I thought it was all about relationships for Salesforce (NYSE:CRM) in the summer of this year. However, the company is experiencing quite a few outflows in the C-suite.
Shares had decreased this summer, trading close to the $175 level significantly, along with the rest of the (technology) market. Salesforce stock received premium valuations for a long time but noticed prices dropping. However, valuations were still very demanding—too demanding for me—based on realistic earnings.
In Brief
Salesforce has grown into a titan in its industry through astute leadership, organic growth, and dealmaking. The company has a strong track record of acquisitions, which includes a larger $15 billion deal for Tableau in 2019. I have long admired the company and Marc Benioff’s leadership, so I was wary of the high truly realistic earnings multiple and the adjusted earnings numbers.
At the time of the Tableau acquisition in the summer of 2019, Salesforce was valued at $125 billion, or eight times its then-reported annual sales of $16 billion. Sales were growing at a rate of about 20%, and GAAP earnings were essentially nonexistent. Shares reached a high of $300 in November 2021 and fell to $175 this summer, the price at which Tableau acquired the company.
Sales for the company reached $26.5 billion in 2021 and are expected to reach $32 billion in 2022. Sales are on track to double from $16 billion in 2019; however, investors have experienced a 25% dilution over the same period, which has constrained the growth in earnings per share. The company was profitable, which is encouraging, but an adjusted earnings figure of $4.78 per share for 2021 was still significantly impacted by stock-based compensation, which trended at almost $3 per share.
The company’s valuation has decreased to approximately six times sales this summer, with shares trading at about 100 times realistic earnings based on real earnings trending around $2 per share. Nearly a billion shares are currently trading at $175. According to the rapidly shrinking sales multiple, there was an appeal on that front; however, the shares’ earnings multiples were far too high to generate any fundamental appeal, with an earnings yield of 1% significantly trailing risk-free rates.
What Took Place?
From July to the present, shares have lost another 25% of their value. They are currently trading close to their lows of about $130 per share as Salesforce’s problems persist despite a modest recovery in the larger market and even among some technology names.
Softer growth is partly to blame for this. A strong dollar reduced reported sales growth by four points, bringing the second quarter’s reported sales growth to 22%. The company reduced the full-year sales guidance to $30.9-$31.0 billion, a billion less than the original guidance, due to the company’s guidance for a meagre 14% increase in third-quarter sales, including a similar currency headwind.
Despite a 5-point headwind from the strong dollar in late November, the company reported a 14% increase in third-quarter sales while maintaining its full-year guidance. The company reported adjusted earnings of $3.56 per share through the first three quarters of the year, a decrease of 40 cents from the prior year. Realistic earnings trend just over a dollar, or about $1.50 per share this year, with stock-based compensation rising to $2.47 per share.
As a consoling sign of the times, the company’s third-quarter adjusted earnings of $1.40 per share were up thirteen cents due to improved cost control. Even with the current slower growth, realistic earnings at this rate could still easily surpass the $2 per share threshold. The company has accumulated a modest net cash position once more amidst a flattish share count of a billion shares. However, trading at $130 per share, the realistic earnings number of around $2 per share still translates to an extremely high valuation.
The sales multiple has decreased to just over 44 times sales at the current $130 billion valuation as earnings multiples become more reasonable but are still far too high. However, the third-quarter margin improvement is noteworthy. The fourth quarter operating margins are anticipated to be around 6.5%, up from a margin of 5.9% in the third quarter. The company is still guiding for full-year GAAP operating margins at 380 basis points of sales, with margins so far reported at 290 basis points. On sales of around $8 billion translates to GAAP operating profits of $500 million, or roughly $0.50 per share.
Personal Issues
Salesforce reports margin gains despite the slow growth, but there are also some personal issues. Bret Taylor is leaving his position as co-CEO of the company, the company announced alongside the third-quarter earnings report. Such turnover is never desirable, even if it is unexpected. Still, it is especially unwelcome given that Mr. Butterfield’s departure was followed in the days that followed by the high-profile departures of Mr. Taylor and Mr. Butterfield (joined with the acquisitions of Tableau and Slack, respectively), indicating real struggles or even fights at the top.
This is undoubtedly bad news because slower growth coupled with unrest at the top is troubling. The business is rapidly becoming extremely profitable, which is a plus (after excluding for stock-based compensation expenses). However, a 65 times earnings multiple in combination with 10-15% growth seems excessive given that higher margins are required to drive fundamental appeal in this case. Considering the fluid and uncertain situation, now may be a good time to gradually start an opportunistic stake in Salesforce stock while being aware of the risks.
Featured Image – Pexels © Lex Photography
